Archives For economics

In its February 25 North Carolina Dental decision, the U.S. Supreme Court, per Justice Anthony Kennedy, held that a state regulatory board that is controlled by market participants in the industry being regulated cannot invoke “state action” antitrust immunity unless it is “actively supervised” by the state. In so ruling, the Court struck a significant blow against protectionist rent-seeking and for economic liberty. (As I stated in a recent Heritage Foundation legal memorandum, “[a] Supreme Court decision accepting this [active supervision] principle might help to curb special-interest favoritism conferred through state law. At the very least, it could complicate the efforts of special interests to protect themselves from competition through regulation.”)

A North Carolina law subjects the licensing of dentistry to a North Carolina State Board of Dental Examiners (Board), six of whose eight members must be licensed dentists. After dentists complained to the Board that non-dentists were charging lower prices than dentists for teeth whitening, the Board sent cease-and-desist letter to non-dentist teeth whitening providers, warning that the unlicensed practice dentistry is a crime. This led non-dentists to cease teeth whitening services in North Carolina. The Federal Trade Commission (FTC) held that the Board’s actions violated Section 5 of the FTC Act, which prohibits unfair methods of competition, the Fourth Circuit agreed, and the Court affirmed the Fourth Circuit’s decision.

In its decision, the Court rejected the claim that state action immunity, which confers immunity on the anticompetitive conduct of states acting in their sovereign capacity, applied to the Board’s actions. The Court stressed that where a state delegates control over a market to a non-sovereign actor, immunity applies only if the state accepts political accountability by actively supervising that actor’s decisions. The Court applied its Midcal test, which requires (1) clear state articulation and (2) active state supervision of decisions by non-sovereign actors for immunity to attach. The Court held that entities designated as state agencies are not exempt from active supervision when they are controlled by market participants, because allowing an exemption in such circumstances would pose the risk of self-dealing that the second prong of Midcal was created to address.

Here, the Board did not contend that the state exercised any (let alone active) supervision over its anticompetitive conduct. The Court closed by summarizing “a few constant requirements of active supervision,” namely, (1) the supervisor must review the substance of the anticompetitive decision, (2) the supervisor must have the power to veto or modify particular decisions for consistency with state policy, (3) “the mere potential for state supervision is not an adequate substitute for a decision by the State,” and (4) “the state supervisor may not itself be an active market participant.” The Court cautioned, however, that “the adequacy of supervision otherwise will depend on all the circumstances of a case.”

Justice Samuel Alito, joined by Justices Antonin Scalia and Clarence Thomas, dissented, arguing that the Court ignored precedent that state agencies created by the state legislature (“[t]he Board is not a private or ‘nonsovereign’ entity”) are shielded by the state action doctrine. “By straying from this simple path” and assessing instead whether individual agencies are subject to regulatory capture, the Court spawned confusion, according to the dissenters. Midcal was inapposite, because it involved a private trade association. The dissenters feared that the majority’s decision may require states “to change the composition of medical, dental, and other boards, but it is not clear what sort of changes are needed to satisfy the test that the Court now adopts.” The dissenters concluded “that determining when regulatory capture has occurred is no simple task. That answer provides a reason for relieving courts from the obligation to make such determinations at all. It does not explain why it is appropriate for the Court to adopt the rather crude test for capture that constitutes the holding of today’s decision.”

The Court’s holding in North Carolina Dental helpfully limits the scope of the Court’s infamous Parker v. Brown decision (which shielded from federal antitrust attack a California raisin producers’ cartel overseen by a state body), without excessively interfering in sovereign state prerogatives. State legislatures may still choose to create self-interested professional regulatory bodies – their sovereignty is not compromised. Now, however, they will have to (1) make it clearer up front that they intend to allow those bodies to displace competition, and (2) subject those bodies to disinterested third party review. These changes should make it far easier for competition advocates (including competition agencies) to spot and publicize welfare-inimical regulatory schemes, and weaken the incentive and ability of rent-seekers to undermine competition through state regulatory processes. All told, the burden these new judicially-imposed constraints will impose on the states appears relatively modest, and should be far outweighed by the substantial welfare benefits they are likely to generate.

PayPal co-founder Peter Thiel has a terrific essay in the Review section of today’s Wall Street Journal. The essay, Competition Is for Losers, is adapted from Mr. Thiel’s soon-to-be-released book, Zero to One: Notes on Startups, or How to Build the Future. Based on the title of the book, I assume it is primarily a how-to guide for entrepreneurs. But if the rest of the book is anything like the essay in today’s Journal, it will also offer lots of guidance to policy makers–antitrust officials in particular.

We antitrusters usually begin with the assumption that monopoly is bad and perfect competition is good. That’s the starting point for most antitrust courses: the professor lays out the model of perfect competition, points to all the wealth it creates and how that wealth is distributed (more to consumers than to producers), and contrasts it to the monopoly pricing model, with its steep marginal revenue curve, hideous “deadweight loss” triangle, and unseemly redistribution of surplus from consumers to producers. Which is better, kids? Why, perfect competition, of course!

Mr. Thiel makes the excellent and oft-neglected point that monopoly power is not necessarily a bad thing. First, monopolists can do certain good things that perfect competitors can’t do:

A monopoly like Google is different. Since it doesn’t have to worry about competing with anyone, it has wider latitude to care about its workers, its products and its impact on the wider world. Google’s motto–“Don’t be evil”–is in part a branding ploy, but it is also characteristic of a kind of business that is successful enough to take ethics seriously without jeopardizing its own existence. In business, money is either an important thing or it is everything. Monopolists can think about things other than making money; non-monopolists can’t. In perfect competition, a business is so focused on today’s margins that it can’t possibly plan for a long-term future. Only one thing can allow a business to transcend the daily brute struggle for survival: monopoly profits.

Fair enough, Thiel. But what about consumers? That model we learned shows us that they’re worse off under monopoly. And what about the deadweight loss triangle–don’t forget about that ugly thing!

So a monopoly is good for everyone on the inside, but what about everyone on the outside? Do outsize profits come at the expense of the rest of society? Actually, yes: Profits come out of customers’ wallets, and monopolies deserve their bad reputations–but only in a world where nothing changes.

Wait a minute, Thiel. Why do you think things are different when we inject “change” into the analysis?

In a static world, a monopolist is just a rent collector. If you corner the market for something, you can jack up the price; others will have no choice but to buy from you. Think of the famous board game: Deeds are shuffled around from player to player, but the board never changes. There is no way to win by inventing a better kind of real estate development. The relative values of the properties are fixed for all time, so all you can do is try to buy them up.

But the world we live in is dynamic: We can invent new and better things. Creative monopolists give customers more choices by adding entirely new categories of abundance to the world. Creative monopolies aren’t just good for the rest of society; they’re powerful engines for making it better.

Even the government knows this: That is why one of the departments works hard to create monopolies (by granting patents to new inventions) even though another part hunts them down (by prosecuting antitrust cases). It is possible to question whether anyone should really be rewarded a monopoly simply for having been the first to think of something like a mobile software design. But something like Apple’s monopoly profits from designing, producing and marketing the iPhone were clearly the reward for creating greater abundance, not artificial scarcity: Customers were happy to finally have the choice of paying high prices to get a smartphone that actually works. The dynamism of new monopolies itself explains why old monopolies don’t strangle innovation. With Apple’s iOS at the forefront, the rise of mobile computing has dramatically reduced Microsoft’s decadeslong operating system dominance.

…If the tendency of monopoly businesses was to hold back progress, they would be dangerous, and we’d be right to oppose them. But the history of progress is a history of better monopoly businesses replacing incumbents. Monopolies drive progress because the promise of years or even decades of monopoly profits provides a powerful incentive to innovate. Then monopolies can keep innovating because profits enable them to make the long-term plans and finance the ambitious research projects that firms locked in competition can’t dream of.

Geez, Thiel. You know who you sound like?Justice Scalia. Here’s how he once explained your idea (to shrieks and howls from many in the antitrust establishment!):

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices–at least for a short period–is what attracts “business acumen” in the first place. It induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

Sounds like you and Scalia are calling for us antitrusters to update our models. Is that it?

So why are economists obsessed with competition as an ideal state? It is a relic of history. Economists copied their mathematics from the work of 19th-century physicists: They see individuals and businesses as interchangeable atoms, not as unique creators. Their theories describe an equilibrium state of perfect competition because that is what’s easy to model, not because it represents the best of business.

C’mon now, Thiel. Surely you don’t expect us antitrusters to defer to you over all these learned economists when it comes to business.

Like this:

The Federal Trade Commission’s (FTC) June 23 Workshop on Conditional Pricing Practices featured a broad airing of views on loyalty discounts and bundled pricing, popular vertical business practices that recently have caused much ink to be spilled by the antitrust commentariat. In addition to predictable academic analyses featuring alternative theoretical anticompetitive effects stories, the Workshop commendably included presentations by Benjamin Klein that featured procompetitive efficiency explanations for loyalty programs and by Daniel Crane that stressed the importance of (1) treating discounts hospitably and (2) requiring proof of harmful foreclosure. On balance, however, the Workshop provided additional fuel for enforcers who are enthused about applying new anticompetitive effects models to bring “problematic” discounting and bundling to heel.

Before U.S. antitrust enforcement agencies launch a new crusade against novel vertical discounting and bundling contracts, however, they may wish to ponder a few salient factors not emphasized in the Workshop.

First, the United States has the most efficient marketing and distribution system in the world, and it has been growing more efficient in recent decades (this is the one part of the American economy that has been a bright spot). Consumers have benefited from more shopping convenience and higher quality/lower priced offerings due to the advent of “big box” superstores, Internet sales engines (and e-commerce in general), and other improvements in both on-line and “bricks and mortar” sales methods.

Second, and relatedly, the Supreme Court’s recognition of vertical contractual efficiencies in GTE-Sylvania (1977) ushered in a period of greatly reduced potential liability for vertical restraints, undoubtedly encouraging economically beneficial marketing improvements. A new government emphasis on investigating and litigating the merits of novel vertical practices (particularly practices that emphasize discounting, which presumptively benefits consumers) could inject costly new uncertainty into the marketing side of business planning, spawn risk aversion, and deter marketing innovations that reduce costs, thereby harming welfare. These harms would mushroom to the extent courts mistakenly “bought into” new theories and incorrectly struck down efficient practices.

Third, in applying new theories of competitive harm, the antitrust enforcers should be mindful of Ronald Coase’s admonition that “if an economist finds something—a business practice of one sort or other—that he does not understand, he looks for a monopoly explanation. And as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation, frequent.” Competition is a discovery procedure. Entrepreneurial businesses constantly seek improvements not just in productive efficiency, but in distribution and marketing efficiencies, in order to eclipse their rivals. As such, entrepreneurs may experiment with new contractual forms (such as bundling and loyalty discounts) in an effort to expand their market shares and grow their firms. Business persons may not know ex ante which particular forms will work. They may try out alternatives, sticking with those that succeed and discarding those that fail, without necessarily being able to articulate precisely the reasons for success or failure. Real results in the market, rather than arcane economic theorems, may be expected to drive their decision-making. Distribution and marketing methods that are successful will be emulated by others and spread. Seen in this light (and relatedly, in light of transaction cost economics explanations for “non-standard” contracts), widespread adoption of new vertical contractual devices most likely indicates that they are efficient (they improve distribution, and imitation is the sincerest form of flattery), not that they represent some new competitive threat. Since an economic model almost always can be ginned up to explain why some new practice may reduce consumer welfare in theory, enforcers should instead focus on hard empirical evidence that output and quality have been reduced due to a restraint before acting. Unfortunately, the mere threat of costly misbegotten investigations may chill businesses’ interest in experimenting with new and potentially beneficial vertical contractual arrangements, reducing innovation and slowing welfare enhancement (consistent with point two, above).

Fifth, a new U.S. antitrust enforcement crusade against conditional pricing could be used by foreign competition agencies to justify further attacks on efficient vertical practices. This could add to the harm suffered by companies (including, of course, U.S.-based multinationals) which would be deterred from maintaining and creating new welfare-beneficial distribution methods. Foreign consumers, of course, would suffer as well.

My caveats should not be read to suggest that the FTC should refrain from pursuing new economic learning on loyalty discounting and bundled pricing, nor on other novel business practices. Nor should it necessarily eschew all enforcement in the vertical restraints area – although that might not be such a bad idea, given error cost and resource constraint issues. (Vertical restraints that are part of a cartel enforcement scheme should be treated as cartel conduct, and, as such, should be fair game, of course.) In order optimally to allocate scarce resources, however, the FTC might benefit by devoting relatively greater attention to the most welfare-inimical competitive abuses – namely, anticompetitive arrangements instigated, shielded, or maintained by government authority. (Hard core private cartel activity is best left to the Justice Department, which can deploy powerful criminal law tools against such schemes.)

Even though some degree of licensing responds to legitimate health and safety concerns (i.e., no fly-by-night heart surgeons), much occupational regulation creates unnecessary barriers to entry into a host of jobs. Excessive licensing confers unwarranted benefits on fortunate incumbents, while effectively barring large numbers of capable individuals from the workforce. (For example, many individuals skilled in natural hair braiding simply cannot afford the 2,100 hours required to obtain a license in Iowa, Nebraska, and South Dakota.) It also imposes additional economic harms, as the FTC’s testimony explains: “[Occupational licensure] regulations may lead to higher prices, lower quality services and products, and less convenience for consumers. In the long term, they can cause lasting damage to competition and the competitive process by rendering markets less responsive to consumer demand and by dampening incentives for innovation in products, services, and business models.” Licensing requirements are often enacted in tandem with other occupational regulations that unjustifiably limit the scope of beneficial services particular professionals can supply – for instance, a ban on tooth cleaning by dental hygienists not acting under a dentist’s supervision that boosts dentists’ income but denies treatment to poor children who have no access to dentists.

I share Alden’s disappointment that the Supreme Court did not overrule Basic v. Levinson in Monday’s Halliburton decision. I’m also surprised by the Court’s ruling. As I explained in this lengthy post, I expected the Court to alter Basic to require Rule 10b-5 plaintiffs to prove that the complained of misrepresentation occasioned a price effect. Instead, the Court maintained Basic’s rule that price impact is presumed if the plaintiff proves that the misinformation was public and material and that “the stock traded in an efficient market.”

An upshot of Monday’s decision is that courts adjudicating Rule 10b-5 class actions will continue to face at the outset not the fairly simple question of whether the misstatement at issue moved the relevant stock’s price but instead whether that stock was traded in an “efficient market.” Focusing on market efficiency—rather than on price impact, ultimately the key question—raises practical difficulties and creates a bit of a paradox.

First, the practical difficulties. How is a court to know whether the market in which a security is traded is “efficient” (or, given that market efficiency is not a binary matter, “efficient enough”)? Chief Justice Roberts’ majority opinion suggested this is a simple inquiry, but it’s not. Courts typically consider a number of factors to assess market efficiency. According to one famous district court decision (Cammer), the relevant factors are: “(1) the stock’s average weekly trading volume; (2) the number of securities analysts that followed and reported on the stock; (3) the presence of market makers and arbitrageurs; (4) the company’s eligibility to file a Form S-3 Registration Statement; and (5) a cause-and-effect relationship, over time, between unexpected corporate events or financial releases and an immediate response in stock price.” In re Xcelera.com Securities Litig., 430 F.3d 503 (2005). Other courts have supplemented these Cammer factors with a few others: market capitalization, the bid/ask spread, float, and analyses of autocorrelation. No one can say, though, how each factor should be assessed (e.g., How many securities analysts must follow the stock? How much autocorrelation is permissible? How large may the bid-ask spread be?). Nor is there guidance on how to balance factors when some weigh in favor of efficiency and others don’t. It’s a crapshoot.

In addition, focusing at the outset on whether the market at issue is efficient creates a market definition paradox in Rule 10b-5 actions. When courts assess whether the market for a company’s stock is efficient, they assume that “the market” consists of trades in that company’s stock. This is apparent from the Cammer (and supplementary) factors, all of which are company-specific. It’s also implicit in portions of the Halliburton majority opinion, such as the observation that the plaintiff “submitted an event study of vari­ous episodes that might have been expected to affect the price of Halliburton’s stock, in order to demonstrate that the market for that stock takes account of material, public information about the company.” (Emphasis added.)

But the semi-strong version of the Efficient Capital Markets Hypothesis (ECMH), the economic theorem upon which Basic rests, rejects the notion that there is a “market” for a single company’s stock. Both the semi-strong ECMH and Basic reason that public misinformation is quickly incorporated into the price of securities traded on public exchanges. Private misinformation, by contrast, usually is not – even when such misinformation results in large trades that significantly alter the quantity demanded or quantity supplied of the relevant stock. The reason private misinformation is not taken to affect a security’s price, even when it results in substantial changes in quantities demanded or supplied, is because the relevant market is not the stock of that particular company but is instead the universe of stocks offering a similar package of risk and reward. Because a private misinformation-induced increase in demand for a single company’s stock – even if large relative to the number of shares outstanding – is likely to be tiny compared to the number of available shares of close substitutes for that company’s stock, private misinformation about a company is unlikely to be reflected in the price of the company’s stock. Public misinformation, by contrast, affects a stock’s price because it not only changes quantities demanded and supplied but also causes investors to adjust their willingness-to-pay or willingness-to-accept. Accordingly, both the semi-strong ECMH and Basic assume that only public misinformation can be assured to affect stock prices. That’s why, as the Halliburton majority observes, there is a presumption of price effect only if the plaintiff proves public misinformation, materiality, and an efficient market. (For a nice explanation of this idea in the context of a real case, see Judge Easterbrook’s opinion in West v. Prudential Securities.)

The paradox, then, is that Basic and the semi-strong ECMH, in requiring public misinformation, assume that the relevant market is not company specific. But for purposes of determining whether the “market” is efficient, the market is assumed to consist of trades of a single company’s stock.

The Supreme Court could have avoided both the practical difficulties in assessing market efficiency and the theoretical paradox identified herein had it altered Basic to require plaintiffs to establish not an efficient market but an actual price impact. Alas.

On June 23 the Supreme Court regrettably declined the chance to stem the abuses of private fraud-based class action securities litigation. In Halliburton v. EPJ Fund (June 23, 2014), a six-Justice Supreme Court majority (Chief Justice Roberts writing for the Court, joined by Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan) reversed the Fifth Circuit and held that a class action certification in a securities fraud case should be denied if the defendants produce evidence rebutting the presumption that defendants’ misrepresentations had a price impact. EPJ Fund filed a class action against Halliburton and one of its executives, alleging that they made misrepresentations designed to inflate Halliburton’s stock price, in violation of Section 10(b)(5) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5. In Basic v. Levinson (1988), the Supreme Court held that: (1) investors could satisfy the requirement that plaintiffs relied on defendants’ misrepresentations in buying stock by invoking a presumption that the price of stock traded reflects all public, material information, including material misrepresentations; but that (2) defendants could rebut this presumption by showing that the misrepresentations had no price impact. Halliburton argued that class certification was inappropriate because the evidence it introduced to disprove loss causation also showed that its alleged misrepresentations had not affected its stock price, thereby rebutting the presumption. The district court rejected Halliburton’s argument and certified the class, and the Fifth Circuit affirmed, concluding that Halliburton could use its evidence only at trial. Although the Court rejected Halliburton’s arguments for overturning Basic, it agreed with Halliburton that defendants must be afforded an opportunity to rebut the presumption of reliance before class certification, because the fact that a misrepresentation has a price impact is “Basic’s fundamental premise.”

Justice Thomas, joined by Scalia and Alito, concurred in the judgment, but argued that the “fraud on the market” (FOTM) theory embodied in Basic should be overruled, based on logic, economic realities (“market efficiency has . . . lost its luster”), and subsequent jurisprudence clarifying class certification requirements. Significantly, the Thomas dissent points to a variety of well-recognized motives for the purchase of securities that have nothing to do with a presumption (key to the FOTM theory) that the market accurately reflects the value of a stock in light of all public information: “Many investors in fact trade for the opposite reason—that is, because they think the market has under- or overvalued the stock, and they believe they can profit from that mispricing. . . . Other investors trade for reasons entirely unrelated to price—for instance, to address changing liquidity needs, tax concerns, or portfolio balancing requirements. . . . In short, Basic’s assumption that all investors rely in common on price integrity is simply wrong.” [citation omitted]

Thomas, Scalia, and Alito are right – the Court’s majority missed a major opportunity to rein in class action opportunism by failing to consign Basic to the graveyard of economically flawed Supreme Court precedents, where it belongs. Given the costs and difficulties inherent in rebutting the presumption of reliance at the class action stage, Halliburton at best appears likely to impose only a minor constraint on securities fraud class actions.

The FOTM presumption that has enabled a substantial rise in securities class action litigation over the last quarter century makes no economic sense, according to the scholarly consensus. What’s more, it imposes a variety of social harms on the very groups that were supposed to benefit from this doctrine, as described in a recent study of the political economy of FOTM. Specifically, longer-term shareholders end up bearing the cost of class action settlements that benefit plaintiffs’ trial lawyers, and to the extent paying and receiving shareholders are fully diversified, FOTM is a wash in terms of compensation that turns into a net loss when costs including attorneys’ fees are included. Moreover, FOTM’s utility as a fraud deterrent is “much muted” because payments are made by the corporation and its insurer, not the individual culpable agents. In short, “[w]hen the dust settles, FOTM not only fails to meet its stated goals, it does not even try.”

In light of these problems, Congress should eliminate the eligibility of private securities fraud suits for class action certification. Moreover, Congress should require a showing of specific reliance on fraudulent information as a prerequisite to any finding of liability in a private individual action. What’s more, Congress ideally should require that the SEC define with greater specificity what categories of conduct it will deem actionable fraud, based on economic analysis, as a prerequisite for bringing enforcement actions in this area.

What about even more far-reaching securities law reforms? Asking Congress to consider decriminalizing insider trading undoubtedly is unrealistic at this juncture, but it is interesting to note that even mainstream journalists are starting to question the social utility of the SEC’s current crackdown on insider trading. This focus may lead to a serious case of misplaced priorities. Notably, as leading Federal District Court Judge (SDNY) and former Assistant U.S. Attorney (AUSA) Jed Rakoff has stressed, AUSAs avoid pursuing far more serious frauds arising out of the 2008 Financial Crisis in favor of bringing insider trading cases because the latter are easier to investigate and prosecute in a few years’ time, and, thus, best enhance the AUSAs’ marketability to law firms. (Hat tip to my Heritage colleague Paul Larkin for the Rakoff reference.)

As the FTC has pointed out, federal antitrust law already permits joint activity by health care providers that benefits consumers and is reasonably necessary to create efficiencies. A framework for assessing such activity is found in joint FTC and DOJ Statements of Antitrust Enforcement in Health Care, supplemented by subsequent agency guidance documents. Moreover, no antitrust exemption is needed to promote efficient cooperative arrangements, because the antitrust laws already allow procompetitive collaborations among competitors.

Legislators should not assume that competitive problems created by COPAs can be cured by active supervision carried out by state officials. Such supervision is difficult, costly, and prone to error, particularly because the supervised entities will have every incentive to mischaracterize their self-serving actions as welfare-enhancing rather than welfare-reducing. In effect, state supervision absent antitrust sanction may devolve into a form of ad hoc economic regulation, subject to all the imperfections of regulation, including regulatory capture by special interests.

A real world example of the difficulties in regulating COPA arrangements is outlined in a 2011 state-commissioned economic analysis (2011 Study) of the 1995 COPA agreement (NC-COPA) between the State of North Carolina and Mission Health Systems (MHS). In 1993 the State of North Carolina enacted a COPA statute, which grants federal and state antitrust immunity to parties that submit their cooperative agreements to active supervision by the State of North Carolina. In 1995, to forestall a DOJ antitrust investigation into the merger of the only two acute-care hospitals in Asheville, North Carolina, MHS, the parent of the acquiring hospital, sought and was granted a COPA by the State. (This COPA agreement was the first in North Carolina and the first in the nation.) MHS subsequently expanded into additional health care ventures in western North Carolina, subject to state regulatory supervision specified in NC-COPA and thus free from antitrust scrutiny. The 2011 Study identified a number of potentially harmful consequences flowing from this regulatory scheme: (1) by regulating MHS’s average margin across all services and geographic areas, NC-COPA creates an incentive for MHS to expand into lower-margin markets to raise price in core markets without violating margin cap limitations; (2) NC-COPA’s cost cap offers only limited regulatory protection for consumers and creates undesirable incentives for MHS to increase outpatient prices and volumes; and (3) NC-COPA creates an incentive and opportunity for MHS to evade price or margin regulation in one market by instead imposing price increases in a related, but unregulated, market. Moreover, the 2011 Study concluded that the NC-COPA was unnecessary to address competitive concerns attributable to the 1995 merger. The State of North Carolina has not yet responded to recommendations in the Study for amending the NC-COPA to address these ills. What the Study illustrates is that even assuming the best of intentions by regulators, COPAs raise serious problems of implementation and are likely to have deleterious unanticipated effects. State governments would be well advised to heed the advice of federal (and state) antitrust enforcers and avoid the temptation to substitute regulation for competitive market forces subject to general antitrust law.

In sum, state legislatures should resist the premise that health care competitors will somehow advance the “public interest” if they are freed from antitrust scrutiny and subjected to COPA regulation. Efficient joint activity can proceed without such special favor, whose natural effect is to incentivize welfare-reducing anticompetitive conduct – conduct which undermines, rather than promotes, health care quality and the general welfare.

Mike Sykuta and I, both proud Missourians, recently took to the opinion section of the Kansas City Star to discuss pending state legislation that would bar automobile manufacturers from operating their own retail outlets in the Show Me state. The immediate target of the bill is Tesla, but the bigger concern of the auto dealers, who drafted the statutory language we criticize, is that the big carmakers will bypass independent dealers and start running their own retail outlets.

The arguments in our op-ed will be familiar to TOTM readers. We begin with three fundamental points: (1) Distribution is an “input” for carmakers. (2) Producers, if left to their own devices, will choose the more efficient option when deciding whether to “buy” the distribution input (i.e., to sell through independent dealers, who pay a discounted wholesale price) or “make” it (i.e., to operate their own retail outlets and charge the higher retail price). (3) Consumers — who ultimately pay all input costs, including the cost of distribution — will benefit if the most efficient option is selected. In short, the interests of carmakers and consumers are aligned here: both benefit from implementation of the most efficient distribution scheme.

We then rebut the arguments that a direct distribution ban is needed to break up monopoly power, to assure adequate aftermarket servicing of vehicles, or to encourage appropriate safety recalls. (On these points, we draw heavily from International Center for Law & Economics’ letter to Gov. Chris Christie regarding New Jersey’s proposed anti-Tesla legislation.)

FTC Commissioner Josh Wright is on a roll. A couple of days before his excellent Ardagh/Saint Gobain dissent addressing merger efficiencies, Wright delivered a terrific speech on minimum resale price maintenance (RPM). The speech, delivered in London to the British Institute of International and Comparative Law, signaled that Wright will seek to correct the FTC’s early post-Leegin mistakes on RPM and will push for the sort of structured rule of reason that is most likely to benefit consumers.

Wright began by acknowledging that minimum RPM is, from a competitive standpoint, a mixed bag. Under certain (rarely existent) circumstances, RPM may occasion anticompetitive harm by facilitating dealer or manufacturer collusion or by acting as an exclusionary device for a dominant manufacturer or retailer. Under more commonly existing sets of circumstances, however, RPM may enhance interbrand competition by reducing dealer free-riding, facilitating the entry of new brands, or encouraging optimal production of output-enhancing dealer services that are not susceptible to free-riding.

Because instances of minimum RPM may be good or bad, liability rules may err in two directions. Overly lenient rules may fail to condemn output-reducing instances of RPM, but overly strict rules will prevent uses of RPM that would benefit consumers by enhancing distributional efficiency. Efforts to tailor a liability rule so that it makes fewer errors (i.e., produces fewer false acquittals or false convictions) will create complexity that makes the rule more difficult for business planners and courts to apply. An optimal liability rule, then, should minimize the sum of “error costs” (social losses from expected false acquittals and false convictions) and “decision costs” (costs of applying the rule).

Crafting such a rule requires judgments about (1) whether RPM is more likely to occasion harmful or beneficial effects, and (2) the magnitude of expected harms or benefits. If most instances of RPM are likely to be harmful, the harm resulting from an instance of RPM is likely to be great, and the foregone efficiencies from false convictions are likely to be minor, then the liability rule should tend toward condemnation – i.e., should be “plaintiff-friendly.” On the other hand, if most instances of RPM are likely to be beneficial, the magnitude of expected benefit is significant, and the social losses from false acquittals are likely small, then a “defendant-friendly” rule is more likely to minimize error costs.

As Commissioner Wright observed, economic theory and empirical evidence about minimum RPM’s competitive effects, as well as intuitions about the magnitude of those various effects, suggest that minimum RPM ought to be subject to a defendant-friendly liability rule that puts the burden on plaintiffs to establish actual or likely competitive harm. With respect to economic theory, procompetitive benefit from RPM is more likely because the necessary conditions for RPM’s anticompetitive effects are rarely satisfied, while the prerequisites to procompetitive benefit often exist. Not surprisingly, then, most studies of minimum RPM have concluded that it is more frequently used to enhance rather than reduce market output. (As I have elsewhere observed and Commissioner Wright acknowledged, the one recent outlier study is methodologically flawed.) In terms of the magnitude of harms from wrongly condemning or wrongly approving instances of RPM, there are good reasons to believe greater harm will result from the former sort of error. The social harm from a false acquittal – enhanced market power – is self-correcting; market power invites entry. A false condemnation, by contrast, can be corrected only by a subsequent judicial, regulatory, or legislative overruling. Moreover, an improper conviction thwarts not just the challenged instance of RPM but also instances contemplated by business planners who would seek to avoid antitrust liability. Taken together, these considerations about the probability and magnitude of various competitive effects argue in favor of a fairly lenient liability rule for minimum RPM – certainly not per se illegality or a “quick look” approach that deems RPM to be inherently suspect and places the burden on the defendant to rebut a presumption of anticompetitive harm.

Commissioner Wright’s call for a more probing rule of reason for minimum RPM represents a substantial improvement on the approach the FTC took in the wake of the U.S. Supreme Court’s 2007 Leegin decision. Shortly after Leegin abrogated the rule of per se illegality for minimum RPM, women’s shoe manufacturer Nine West petitioned the Commission to modify a pre-Leegin consent decree constraining Nine West’s use of RPM arrangements. In agreeing to modify (but not eliminate) the restrictions, the Commission endorsed a liability rule that would deem RPM to be inherently suspect (and thus presumptively illegal) unless the defendant could establish an absence of the so-called “Leegin factors” – i.e., that there was no dealer or manufacturer market power, that RPM was not widely used in the relevant market, and that the RPM at issue was not dealer-initiated.

The FTC’s fairly pro-plaintiff approach was deficient in that it simply lifted a few words from Leegin without paying close attention to the economics of RPM. As Commissioner Wright explained,

[C]ritical to any decision to structure the rule of reason for minimum RPM is that the relevant analytical factors correctly match the economic evidence. For instance, some of the factors identified by the Leegin Court as relevant for identifying whether a particular minimum RPM agreement might be anticompetitive actually shed little light on competitive effects. For example, the Leegin Court noted that “the source of the constraint might also be an important consideration” and observed that retailer-initiated restraints are more likely to be anticompetitive than manufacturer-initiated restraints. But economic evidence recognizes that because retailers in effect sell promotional services to manufacturers and benefit from such contracts, it is equally as possible that retailers will initiate minimum RPM agreements as manufacturers. Imposing a structured rule of reason standard that treats retailer-initiated minimum RPM more restrictively would thus undermine the benefits of the rule of reason.

Commissioner Wright’s remarks give me hope that the FTC will eventually embrace an economically sensible liability rule for RPM. Now, if we could only get those pesky state policy makers to modernize their outdated RPM thinking. As Commissioner Wright recently observed, policy advocacy “is a weapon the FTC has wielded effectively and consistently over time.” Perhaps the Commission, spurred by Wright, will exercise its policy advocacy prowess on the backward states that continue to demonize minimum RPM arrangements.

Like this:

The world of economics and public policy has lost yet another giant. Joining Ronald Coase, James Buchanan, Armen Alchian, and Robert Bork is a man whose name may be less familiar to TOTM readers but whose ideas have been hugely influential, particularly on me.

As the first chairman of President Reagan’s Council of Economic Advisers, Murray Weidenbaum lay much of the blame for the anemic economy President Reagan “inherited” (my, how I’ve come to hate that word!) on the then-existing regulatory state. Command and control dominated in those days, and there was virtually no consideration of such mundane matters as the costs and benefits of regulatory interventions and the degree to which regulations were tailored to fit the market failures they purported to correct. Murray understood that such an unmoored regulatory state strangled innovation and would inevitably become co-opted by regulatees, who would use the machinery of the state to squelch competition and gain other advantages. He counseled the President to do something about it.

The result was Executive Order 12291, which subjected major federal regulations to cost-benefit analysis and stated that “[r]egulatory action shall not be undertaken unless the potential benefits to society from the regulation outweigh the potential costs to society.” Such basic cost-benefit balancing seems like nothing more than common sense these days, but when Murray was pushing the idea at Washington University back in the late 1970s, it was considered pretty radical. Many of the Nixon era environmental statutes, for example, proudly eschewed consideration of costs. Murray helped us see how silly that was.

I distinctly remember a conversation we had in 1993. I had just been hired as a research fellow at Wash U’s Center for the Study of American Business, and Murray, the Center director, was taking me and the other research fellow to lunch. The faculty dining club at Wash U is across a busy-ish street from the main campus. There’s a tunnel a block or so west of the dining club, but hardly anybody would use it when walking to lunch. As we waited for an opening in traffic and crossed the street, Murray remarked, “See fellows, this is what I’m talking about. Crossing this busy street is risky. All these lunch-goers could eliminate the risk of an accident by walking two blocks out of their way. But nobody ever does that. The risk reduction just isn’t worth the cost.”

That was classic Murray. He was a plain-talking purveyor of common sense. He was firm in his beliefs but always kind and never doctrinaire. By presenting his ideas calmly and rationally, he earned the respect of differently minded folks, like Democratic Senator Thomas Eagleton, with whom he co-taught a popular course at Wash U. Our country is a better place because of Murray’s service, and I am where I am because he took me under his wing.